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Friday, February 24, 2017

My latest Macro Musings podcast is with Hester Peirce. Hestor is a Senior Research Fellow and director of the Financial Markets Working Group at the Mercatus Center. She previously served on Senator Richard Shelby’s staff on the Senate Committee on Banking, Housing, and Urban Affairs. In that position, she worked on financial regulatory reform following the financial crisis of 2008 as well as oversight of the regulatory implementation of the Dodd-Frank Act. Hester also served at the Securities and Exchange Commission as a staff attorney and as counsel to Commissioner Paul S. Atkins. Hester was also nominated by President Obama to be an SEC Commisioner.

We spent most of our time talking about how to improve the stability of the financial system. The laws and regulations emanating from Dodd-Frank (DF) were supposed to make the financial system safer, but a number of recent papers--Nissim and Calormiris (2014), Sarin and Summers (2016), Chousaks and Gorton (2017)--find the banking system weaker now and not meaningfully safer than pre-2008. Others, like Minneapolis Fed President Neel Kashkari, are worried about financial institution that remain too big to fail (TBTF) since they still fund with too much debt. Moreover, it is not clear if the reforms made in DF, like living wills and the Financial Stability Oversight Council, will actually make much difference should the TBTF institutions get in trouble again. President Kashkari, consequently, has proposed a number of reforms to end TBTF.

Hester and I discussed these concerns as well as the possibility that DF has actually increased the fragility of the financial system. One area, in particular, that is creating new potential problems for financial stability is the new DF central clearinghouse utility for derivatives. These central clearinghouses or CCPs were created as a way to improve transparency about derivatives so that regulators and other observer would know what is happening in this part of the financial system. Ironically, however, they appear to be making the financial system more fragile. This is because the CCPs concentrate all the risk from formerly bilateral relationships into one financial firm, making it another TBTF institution. Put differently, DF has inadvertently created more Lehmans or AIGs.

Hester and I do discuss other issues that are covered in the book, but I wanted to highlight here what I see as one of the bigger issues still facing us eight years after the crisis.

If you are interested in the book, you can download it or individual chapters from here. This is a great resource to have as the new President and Congress consider revamping financial regulation.

This was a fascinating conversation throughout. You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more episodes are coming.

Friday, February 17, 2017

My latest Macro Musings podcast is with Sebastian Mallaby.
Sebastian is a senior fellow at the Council on Foreign Relations and a contributing columnist to the Washington Post. Previously, he worked with the Financial Times and the Economist magazine and is the author of several books. He joined me to talk about his latest book “The Man Who Knew: The Life and Times of Alan Greenspan”.

This was a fascinating conversation throughout. You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more episodes are coming.

Monday, February 13, 2017

[A] defining feature of the US financial system is that its central bank, the Federal Reserve, has inordinate influence over global monetary conditions. Because of this influence, it shapes the growth path of global aggregate demand more than any other central bank does. This global reach of the Federal Reserve arises for three reasons.

First, many emerging and some advanced economies either explicitly or implicitly peg their currency to the US dollar given its reserve currency status. Doing so, as first noted by Mundell (1963), implies these countries have delegated their monetary policy to the Federal Reserve as they have moved towards open capital markets over the past few decades.

These “dollar bloc” countries, in other words, have effectively set their monetary policies on autopilot, exposed to the machinations of US monetary policy. Consequently, when the Federal Reserve adjusts its target interest rate or engages in quantitative easing, the periphery economies pegging to the dollar mostly follow suit with similar adjustments to their own monetary conditions.

[...]

The second reason for the global reach of US monetary policy is that a large and growing share of global credit is denominated in dollars. That means the Federal Reserve’s influence over the dollar’s value gives it influence over the external debt burdens of many countries.

[...]

The third reason for the extended reach of US monetary policy is that other advanced- economy central banks are likely to be mindful of, and respond to, Federal Reserve policy given the large size of the dollar bloc... These findings imply that even inflation- targeting central banks in advanced economies with developed financial markets are not immune from the influence of Federal Reserve policy. This has led Rey (2013, 2015) to argue that the standard macroeconomic trilemma view is incomplete.

There is more in our article, but I wanted to share this excerpt because a new working paper from Ethan Ilzetzki, Carmen Reinhart, and Kenneth Rogoff sheds light on our claim that Fed is a monetary superpower.

Specifically, this new paper shows that contrary to conventional wisdom exchange rate regimes across the world have not become significantly more flexible since the end of the Bretton Woods System. This surprising finding is backed up by a large cross-country data set that spans the period 1946-2015. Moreover, they show that the limited exchange rate flexibility has coincided with an expanding reach of the dollar. From their abstract:

Our central finding is that the US dollar scores (by a wide margin) as the world’s dominant anchor currency and, by some metrics, its use is far wider today than 70 years ago.

Here is the key chart from their paper as it relates the monetary superpower argument. It shows the share of world GDP that has the dollar as its anchor currency:

What this graph implies is that about 70 percent of world GDP has its monetary policy effectively set by the FOMC! Given the size of the dollar bloc and its spillover effects, it is likely the Fed's total influence on global monetary conditions is even larger.

This is staggering. It means that twelve Fed officials that meet in Washington D.C. largely determine global monetary conditions. The Fed is truly a monetary superpower.

Friday, February 10, 2017

My latest Macro Musings podcast is with Eswar Prasad. Eswar is a professor of economics at Cornell University and a senior fellow at Brookings Institution. He joined me to talk about his new book, Gaining Currency: the Rise of the Renminbi.

We began by reviewing the history of money in China. Many people know that China had the first paper currency, but few appreciate that China had the first debates over monetary theory and role of the state in money creation. China also had the first currency war--literally a physical war between two competing central banks in China--as well as its own interesting monetary history during the Great Depression of the 1930s.

We then moved to China's exchange rate regime and the thorny question of whether China's currency being undervalued in the past and whether it was now overvalued. We also discussed how consequential was the past undervaluation of China's currency to the huge trade surplus it ran with the United States. Our conversation also covered the role the Fed played in setting monetary conditions in China via its currency peg to the dollar.

The interview wrapped up by considering the prospects of the Renminbi becoming a truly important currency. This was a fascinating conversation throughout.

You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more episodes are coming.

Friday, February 3, 2017

My latest Macro Musing podcast is with Jesus Fernandez-Villaverde. Jesus is a professor of economics the University of Pennsylvania, a research associate with the National Bureau of Economic Research, and a research affiliate with the Centre for Economic Policy Research.

Jesus does theoretical macroeconomic modeling, econometrics, and economic history. He has several books coming out on those topics and recently coauthored a chapter in the Handbook of Macroeconomics titled "Solution and Estimation Methods for DSGE Models". He joined me to talk about European economic history and macroeconomic modeling on the show.

Most of our conversation focused on German monetary history in the 20th century since it has been so consequential for the rest of the Europe. We began by discussing the Weimar hyperinflation of the early-to-mid 1920s and the Great Depression of the late 1920s-early 1930s. It is hard to appreciate the fact that Germany went from hyperinflation to painful deflation in a decade. Several interesting questions come out this experience. First, which is worse: hyperinflation or depression? Second, why do the Germans seem to remember the former more than the later? Third, is it true that the Great Depression brought the Nazis to power? Jesus provides good answers to these in the interview. We also touch on Bretton Woods, the EMS crisis in 1992, the advent of the Eurozone, and the best path forward for this currency union.

Jesus and I then turn to the current debate over DSGE modeling in macroeconomics. He responds to recent criticism of this approach and also considers the the future of monetary search models in this field.

This was a fascinating conversation throughout. You can listen to the podcast on Soundcloud, iTunes, or your favorite podcast app. You can also listen via the embedded player above. And remember to subscribe since more episodes are coming.

Update: Since we talked about it in the podcast, here is a chart I created some time ago on the EMS crisis in 1992 . It shows Germany's tightening of monetary policy pulling down (via the peg) nominal demand in other European countries. It is also shows a recovery in UK nominal spending once the peg was broken.